The Ultimate Guide to
How to Find the Best Brokers for Commodity Trading For You
Commodity Trading is the trading of a physical product that is typically bought and sold in an established financial exchange. Commodity trading can be a popular choice for traders because of the potentially increased returns (with the subsequently increased risks) offered by the high leverage usually associated with commodities.
These higher levels of leverage, coupled with the use of margin deposits where the broker essentially lends the trader the remaining portion of the actual commodity value, means a trader can make multiples of his investment if the commodity price moves in a favourable direction. These margin deposits will then usually be charged an overnight financing charge. For example, popular CFD broker City Index will charge an overnight fee +/– 2.5% annual charge above or below the relevant base rate
However, it is important to remember that the opposite is also true that if the market moves against the trader then their losses can be much more magnified.
For example:
1. A trader buys a commodities futures contract for gold, where the cost per ounce of gold is $1,000.
2. They agree to 2 contracts at a weight of 100 ounces per contract.
3. The full contract cost therefore totals $200,000 ($1,000 x 2 x 100).
4. The trader makes a margin deposit of 6% which totals $12,000 (0.06 x 1,000 x 2 x 100).
5. The broker is therefore technically lending them the difference of $188,000.
6. The price of gold then increases by 1% to $1010 per ounce.
7. The trader’s profit will therefore be $2000 ($1010 x 100 x 2 = $202,000 – $200,000).
8. The trader’s return on their investment will total 16.67% (2000/12000).
So, with an account balance of $12,000, the trader will have made a profit of $2000 (16.67%) with just a 1% price increase in the commodity.
However, it is important to note that if the price had fallen by the same amount, the trader would have made a loss of 16.67%, with the commodity having only suffered a 1% fall in price.
How Commodities are Traded
Commodities can typically be traded on the futures market through futures contracts, which are short term contracts with definite expiry dates. However, commodities may also be traded indirectly through the equities market, through mutual funds, through exchange-traded funds (ETFs) or through a contract for difference (CFD) trading platform.
Leverage and smaller contract sizes are two factors that attract traders to trading futures contracts as CFDs (contracts for difference) rather than traditional trading. With a combination of smaller contracts and leverage, the initial capital requirements for traders is significantly lower.
Unlike manufacturers, most traders do not want the actual delivery of the commodity they are trading, therefore a commodities trader will usually opt to roll-over the futures contract for that commodity. A commodities roll-over effectively extends the expiration date for the settlement of the contract, allowing the trader to avoid the costs associated with the settlement of an expired futures contract.
